OnStartups

I’m going to open this article with a short (and true) story. I officially kicked off my marketing software company, HubSpot, about 17 months ago. If you’ve read my blog for any period of time, you likely know that I’m a big beliver in the “charge early, charge often” mantra. As it turns out, in order to “charge early”, you have to figure out what you’re going to charge people. That is, you have to have a price for your product. Thankfully, both my co-founder (Brian Halligan) and I had recently graduated from a top 5 MBA program. And, it wasn’t just any top 5 program — it was MIT. You know, that place where science and math and uber-geeky analytical stuff happens. So, you’d think that when it came time to figure out a price for our product, we’d really dig in, do some heavy-duty analysis, some really hard thinking and come up with a relatively well thought-out price. That’s not what happened.

When it came to deciding on the price for our software, we basically just rolled the dice.

I’d love to for the statement above to be an exaggeration. Surely, we spent some time pondering that oh-so-important factor in our business sucess. Nope. We didn’t. One of us (I think it was me) suggested “how about $250/month”, and that’s what we went with. And, that’s where the price remained for about 2 years.

Things turned out fine for me and HubSpot. But, you still shouldn’t do this. Don’t just roll the dice when it comes to pricing your product. Give it some thought, consideration and (gasp!) some analysis. Your first step towards this path should be to run over, right now, and get the book “Don’t Just Roll The Dice: A usefully short guide to software pricing” by Neil Davidson. Even if Neil weren’t such a nice guy (he is) and even if he doesn’t run my favorite conference (he does) and even if he didn’t build a really successful software company himself (he did), I’d still implore you to read the book. It’s got the highest value-to-length ratio I’ve seen in a business book in a long time. Go get it, right now. And, if you’re still not convinced, Neil’s even been nice enough to give it away for free in convenient PDF form. Yes, that’s right, you don’t even have to buy the freakin’ book on Amazon for $9.95 (though you could).

Just on the off-chance that I caught you at a particularly skeptical time and you’re still not convinced, here are some of my notes from the book.

Insights On Software Pricing From “Don’t Just Roll The Dice”

1. Your product is more than just your product. You might think that your software product is just the bits and bytes that your customers download (or access online), but you’d be wrong. What customers are actually paying you for is the entire experience of doing business with you. Everything from how you market and sell the product, to how you help people use it and how you maintain it going forward. All of it. Your pricing should be based on this reality.

2. There’s a difference between perceived and objective value. It doesn’t matter how much “real” (objective) value you have baked into your product if your customers don’t perceive that value, they are not going to pay as much for it. Hopefully, their perceived value is a function, to some degree, of the objective value. If not, you’re screwing something up.

3. Community matters. The group that your customers belong to, or want to belong to will impact the price they’re willing to pay. For example, some people buy hybrid cars not just because of the environmental benefit or the higher mileage but because they want to be part of that community. The same reason some people buy a BMW. Determine what kind of community you can build (or tap into) around your offering. Help people belong to the community they want to belong to.

4. As it turns out, people do buy drills (not holes). There’s the reasonably famous adage around “people buy holes, not drills”. The point is to focus on the benefit to the customer (not the product itself). I generally agree with that notion. But, it’s useful to keep in mind that holes can be a commodity, but people still sometimes pay $400 for a drill. Benefits are important, but the direct benefiit is not the only one that customers value.

5. The more differentiated you are, the more you control price. This one should be obvious. If you have a product that’s about the same as all of your competitors, then you don’t really set your price — the market does. Of course, nobody thinks of themselves as being identical to their competition (especially software companies). But, what we often forget is that it’s difficult — and very risky, to try and create a completely new category and be totally differentiated. Decide which dimension you’re going to differentiate on and make sure it’s reasonable given your particular constraints (like cash).

6. No battle plan survives contact with the enemy. This quote is not actually in the book, but I think it still fits the theme. When setting pricing, it’s important to consider what the “market response” is going to be — particularly if you’re in a well-defined category. Just because it doesn’t make economic sense for a competitor to get in to a price war with you, it doesn’t mean they won’t do it. Particularly if they’re big or well-funded. If you’re thinking about competing on price, keep that in mind. Better yet, don’t do it at all.

7. Remember to be fair. As humans, we often have a sense of what we think “fair” pricing is. Even though a particular pricing model is “theoretically optimal”, it might not be wise in practice. As software entrepreneurs, we often think we can get away with certain types of price segmenting simply because it’s enforceable in the software. Just because you can keep customers from doing certain kinds of things (unless they pay up), doesn’t necessarily mean it’s the right (optimal) thing to do. In the long term, it could actually hurt. Try to put yourself in the customer’s shoes and envision if they think the way you price things is fair. [Note: I’m not suggesting you be all rainbows and cupcakes and suggest that you price based on being “nice”. I’m just saying that you might actually make more money by being empathetic]

8. Pricing complexity has a cost. One of the things you learn in micro economics (and is discussed in the beginning of the book) is the concept of supply and demand curves and how you can segment your pricing in order to capture the maximum value (i.e. optimize revenues). This can be a wonderful thing. But, it’s critical to remember that this segmentation has a price — it’s not free revenue. For example, when HubSpot went from a single price ($250/month) to two prices (still pretty simple), life got a lot harder. All of a sudden, our marketing, sales and even our operational efforts got more complicated. The product got more complicated. All of our pretty charts that we used to talk about the business and measure success got more complicated. The reality is that when you add a new dimension to your pricing structure, you’re adding a new dimension of complexity. Oh, and by the way, the *second* price that you add to your product is the most expensive. After that (third, fourth, etc.) things get a tad easier because you’ve already built some of the infrastructure to support multiple prices. And by that point, your brain is already used to the pain.

Phew! I typed this entire article in one sitting while simultaneously reading a majority of the book for a second time. If I haven’t convinced you yet that you should go read it then I think I’m hopelessly inadequate at conveying the importance of this topic and the usefulness of the book. Or, maybe you’ve already got it all figured out. If so, may the wind be in your sails and may you go forth and prosper. For the rest of you, just download the book.

And, on a more selfish note, what are your biggest insights when it comes to software pricing? What challenges have you dealt with? What questions do you have about pricing your software? If you’re looking for some great answers, you can post a question on Answers.OnStartups.com where a bunch of smart folks like Neil Davidson (the guy that wrote the book) hang out. Hope to see you there.

I'm buying the book. And I'm paying for it too. Because: -it's a great review you did -you've written excellent stuff before -people doing what you do deserve to be supported. I appreciate the free link, thank you very much, but I'm paying. Cuz that's the way things should work.

Thanks for the post and book review. Timely as I'm working on pricing and package offering for a B2B buying network. I too would be interested in your thoughts around free, entry level offerings - hubspot certainly has this in its portfolio.

Great article. I think that everything mentioned here applies to product pricing in general, not just software; and this information is especially relevant in this economy. Poor companies and products cannot just "get by" anymore, as consumers have sharpened their buying focus and tightened their purses due to the economy.

Ok since you did such a good job of describing your guessing on Price and the associated pain with changing it (adding a second tier) I will get the book so that I can learn more about Neil's approach as well as how to apply for my business endeavors.

Great post! We had a difficult time as well determining the price for our SEO management tool. We kinda knew what the computational resources were (servers, API usage, etc.), and we did some homework on what other companies were charging for something similar, but it came down to what price did we think users would be willing to pay for the service, and not have to go and get multiple approvals for. Someone told me "you should take the price you are thinking and multiply that by 4" as their argument was if you price it too low, you will have a much harder time raising prices later. Well, I didn't do that, and the product is in free beta trial right now anyway. Thanks for the post - I'm going to buy that book too!

Just saw some Hubspot guys at the ULS meeting in Boston a couple of weeks ago. Cool stuff, congrats on the success, and all the power to you. Good article and I agree with previous comments, definitely applies across the board product wise.

All excellent insights. From a broad perspective, I look at pricing as top: what the market will bear; bottom: your absolute minimum that makes sense to stay in business. Use reference points as well as a starting point, i.e., how are similar products/services priced and the associated consumer behaviors. Then, differentiation value moves the price up; competitive forces move the price down. And don't forget, your price will influence consumer behavior -- be sure you understand what actions you're trying to drive, i.e., signups, usage, etc.

Frank

If you happen to skip it until now, that MYPS site is spam. Maybe it's great, but not as helpful as this post for sure.

Thanks Dharmesh for another excellent review!

Inquire_98

"Great" post!!!

Really a "good" read...

Thank you,

Daniel Llamas

The main point is to have a clear idea of what is value the customer is giving to the product and what is different from other "similar" solutions. In software products / solutions what you folks shouldn´t be doing is to base a price on your costs.

Regarding the book, since I live in Mexico City I´ll take the offer download it.

Lars Holmqvist

Thankyou for a great article. Pricing software is an issue that my partners and I are struggling with right now. And yes, I've ordered the book on Amazon,

OSSIE

Thank you for a great post, and for linking the book... I will delve in ASAP!!! Appreciate all the pointers...

Good post. I think there's a better way if you're doing webapps though. Since you can change the price for each customer in the backend code you can actually start doing statistics and find out where you maximise your profit.

Since you can change the price for each customer in the backend code you can actually start doing statistics and find out where you maximise your profit.

Not a good idea. Go to the Google Sketchup site and buy Sketchup Pro. You'll be charged £341.00 + VAT (in the UK).

The problem with this is that there are other Google documents that list the price as £318.00 + VAT.

How do I know this? My girlfriend purchased Sketchup Pro, then a few days later an email from the evaluation program arrived with a link to the page with the £318.00 prices in it. She was livid! She called them "bastards".

I contacted Google Sketchup sales team and sorted the issue out (she got a refund of the difference).

Think you can get away with this? People will find out. Private, per customer deals based on volume are one thing, but split testing them like you are saying, thats another kettle of fish.

As for Neil's book. Its a good read. I'm not a fast reader. I read this book in two sittings in one day. Worth reading.

Stephen Kellett

Dharmesh,

When posting the previous comment I noticed that you site contacts Google Analytics. Why? Surely you are using Hubspot on this site? If you are using Hubspot on this site, why would be using Google Analytics?

Dharmesh Shah

Thanks everyone. All of your interest has helped drive Neil's book up the charts on Amazon.

Stephen: I do use HubSpot analytics as the primary tool for tracking things on this blog, but I like to keep GA running just so I stay up to speed on what's going on.

It's a tradeoff of course, and I think the model should only be used initially to find the right price point. I haven't done the math, but I think you can hone in on the optimal price with surprisingly few samples.

There's of course also the possibility of letting potential customers go through with the purchase, and only afterwards inform them that the price they were willing to pay is above the price that is charged, and they will only have to pay the lower price. The problem can certainly be solved with a bit of psychology.

Very nice and informative article. I have downloaded the book and am sure it would be a nice read too. I am offering my products through my website www.apnitaly.com which provides free service to the users of Tally accounting and inventory management software. Lets see how successfull i will be in my product pricing.

I do not like the most popular SaaS pricing model- freemium. Here I talked about why? The ethical question here is who is paying for all the free accounts? You guessed it right- the paying customers. What a irony. However, freemium model makes sense when I group users say buyers are subsidized by another group of users- the sellers. In this case everybody wins. See why we priced our ScrumPad.

I would be interested to hear from you all the issue I raise about freemium model.

Yet another great article from Dharmesh. Pricing is an area that can be very tricky for most entrepreneurs. Particularly love point #8. This is the Jobsian (Apple) approach - keep the pricing tiers to the minimum to avoid customer confusion. Another mistake I have seen people make is to use "cost-based pricing" (adding a markup over one's costs).

This is a great article, you could even take out the generic principles and use it accross any business. Thanks for the link and the free download. You deserve to be successful for all your efforts and supported. All the best with your business! Roisin

Good article here, and yes you should do some analysis of what the cost will be. Whether it is a product or service, you can calculate what the cost is of production - you can also check out what the competition charges.

Remember it is very hard to put your prices up!! So get it right first time.

Dharmesh, thanks for the great post! I've been looking for a better way to make decisions about pricing our different software modules, so this is very timely Incidentally, the book was sold out on both Amazon and B&N (speaks volumes to your influence :-) but I found it at a smaller online bookstore.

My startup is just at the point where we are deciding on price, and I stumbled across this ebook some time ago. I posted a mini-review on my blog with takeaways specific to my company -- a pre-revenue SaaS startup. Feel free to take a look: http://sagepoint.blogspot.com/2009/11/monetize-your-product-or-pay-price.html

Thanks! Rich

Steve Burigana

Great Post! Your summary was great and the topics covered validate my own experiences. I will be buying multiple copies of the book as xmas gifts for business partners who may be tired of my thoughts on the subject and more apt to accept the concepts when espoused by others (especially in print).

Stephen Kellett

@Max Tobiasen

Be careful what you do. It is illegal in the UK to advertise at price X but then charge more than X for the purchase (*). Charging less is OK.

Other jurisdications will be different.

Hence my comments. If Google Sketchup had refused to refund the difference they could have ended up in court with all the negative publicity involved. The did the right thing, with the minimum of fuss etc.

Stephen

(*) Unless the higher price is a result of VAT being added to the price.

You are meant to advertise prices including VAT, but with the internet that isn't possible - to cover all possibilities you have to advertise the non VAT (sales tax) price and include a notification that VAT will be added if applicable.

Good and lots of information in this article. My advice, start of course by taking all the existing info that you can find but then don't forget to ask your potential customers about the price they would be ready to spend on your service/product. Do some primary research, quantitative research!

First of all, kudos for this book. Having been involved in pricing for my company's product line, I followed many points the book outlines, although that was about a year ago. That's why I can relate to it - the product we sell is actually doing quite well. We being an Indian company (now 6 years old, with multi-geography location, self-funded) had to think a lot before the pricing, especially for different regions for different packages and the points I read about make a lot of sense even now (now that I am a lot wiser). Couldn't have come at a better time, and my heartiest thanks to the author for sharing it. Look forward to more stuff like this coming our way.

I'm good with everything except for #4. That one just doesn't seem right. I'll have to check that one in the book. With #6 I would not be too quick to change you plan just because the market responds. Hopefully you took this possibility into account in your planning. If you just pull your price out of a hat how do you know how to respond? It's curious. Thanks for the article and the reference to the book.

Pricing isn't rocket science. But software pricing is especially tricky because of all the "moving parts" in an offering which includes product characteristics - features, UI, speed, reliability - and services.

"Rolling the Dice..." is a great start but life gets really complicated when it comes to the use of packaging, positioning against a range of competitors and sales across multiple segments.

With all the competition in SaaS, it is crucial to get the price-value balance correct. Some of the resources at www.softwarepricing.com might be useful.

Great advice for startups! I wish I'd read this two months ago when we started creating (then scrapping and restarting multiple times) our pricing algorithm. I'm going to read that book though...we might have to modify our pricing after I read it! Look forward to reading more posts.

Thanks for the timely pointer. I just downloaded the book. During our pricing exercise for our LeadPro247 marketing automation service, we went through several iterations before zeroing in on a suitable pricing plan. It is certainly not a pure science, though it cannot be finalized by rolling the dice. It is difficult to quantify the perceived value and hence takes time. I guess Neil's book will be of great benefit; let me go read now!

My son sent me a link to this blog question as I am the owner of a Software Company that had this challenge a number of years ago. I enjoyed the topic and the comments so I thought I would add to it.

At the time I worked for another company and I was nurturing a new software product I and a partner at the time developed. The new product’s best fit was the manufacturing sector. A colleague at that company was working towards his MBA at a very prestigious Canadian University and suggested he would speak to his professor and have the pricing of the product as an exercise for the class. The professor agreed and they went to work applying the best techniques of the time to the pricing exercise. At the end of the process the professor commented to my colleague that the results were only to used as reference material for the ultimate decision and he then added “tell him to test a high price, a middle price and a low price and go with the best result”.

Needless to say I was somewhat underwhelmed with these results and felt no further ahead.

Ultimately my decision on pricing was determined by my work on a Purchasing System and had to implement signing authority levels. I knew from experience that the customer who would make the purchase decision of my new product would be a first or second line manager. My work on the signing authorities told me that was between $500 - $1,000 at our company. A little more work told me that the $500 mark covered the majority of companies I researched so the price became $499.

To date that product has sold in over 70 countries around the world. Not sure what mark the thought process would get in an MBA program but it worked for us

Andrew Dike

Very useful article. I'm halfway through the ebook and it's been really enlightening. Great for entrepreneurs to get a real understanding of how pricing works.

this is a great commentary. For those of us Geeks who love technology and have no idea what a pricing model should look like, this seems like a great place to start. I will definitely be picking this one up.

As a recent buyer of CRM software, I find it very difficult to accept when a big quote is provided (me not coming from a software background). So, we have just employed an IT manager who deals with all issues related to IT.

Dharmesh, I cant believe that the $250/month price was picked just like that. When we were picking the price for our product, we figured (based on several assumptions) how much it would cost to reach 100 ppl and convince one of them to buy the product. The price was based on that cost and some margin. And we are nowhere as successful as HubSpot.

I just signed up for HubSpot btw - the $250/month product. Perhaps inbound will be more successful than outbound and the analysis will not matter even a bit. Or so I hope!

Marketing as an entire process also includes the vital auxiliary functions of production planning, production and dissemination of market information, financing of markets and their administration, the activities of marketing intermediaries, the provision of training and extension to individuals and groups involved in marketing, and research activities which seek to improve the marketing system in some way.

Nanda

Dharmesh, thank you for the wonderful post! I've been looking for a better way to make decisions about pricing our software product.

Great post Dharmesh. Happy DeLurking Day 2010. http://www.jeffbennett.com/2010/01/today-is-delurker-day/ ...a few days late. I have you on my blog roll and lurk @ your blog often. i am going to try to get more into the dialogue this year with comments. I encourage you to do this same on my blog. Rock on.

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